Exhibit 99.1
KPMG
707 Seventeenth Street Telephone 303 296 2323
Suite 2300 Fax 303 295-8829
Denver, CO 80202
September 14, 2000
Members of the Audit Committee
Vari-L Company, Inc.
4895 Peoria Street
Denver, Colorado 80239
Gentlemen:
The following sets forth our conclusions based on the work performed
through the date of this report, in connection with our engagement to
provide consulting services to you related to the Audit Committee's
investigation of the accounting irregularities which resulted in
misstatements of the historical financial statements of Vari-L Company,
Inc. ("Company"). This matter is also the subject of an on-going
investigation by the Enforcement Division of the Securities and Exchange
Commission (SEC).
The terms and conditions of our engagement are included in our engagement
letter dated June 28, 2000. The scope of our engagement and procedures
described below do not constitute an attest services engagement as that
term is defined by the American Institute of Certified Public Accountants.
This engagement was performed under the rules for management consulting
engagements as promulgated by the American Institute of Certified Public
Accountants. This report has been prepared in connection with the
aforementioned matter. This report is to be used solely for the purposes
of the subject engagement and is not to be used or relied upon for any
other purpose without the express written consent of KPMG LLP.
PROCEDURES PERFORMED
This report addresses those conclusions and observations developed solely
through the conduct of the accounting-related investigative procedures
performed through the date of this letter. The tasks undertaken in
developing our conclusions and observations contained in this report
include the following:
o Reviewed the Company's periodic filings with the SEC, including
Form 10-KSB filings for the years ended December 31, 1999 and 1998
and Form 10-QSB filings for each of the first three quarters
within those years, as well as the Form 10-QSB for the quarter
ended March 31, 2000;
o Reviewed Company prepared accounting records, including available
general ledgers, accounts receivable ledgers, accounts payable
ledgers and similar summary ledgers;
o Reviewed Company prepared summary accounting reports and analyses;
o Reviewed copies of documents produced by the Company in response
to subpoenas from the SEC;
o Reviewed copies of the audit work papers for the auof Haugen
Springer & Co. which were provided to us by the Company. Copies
of the audit work papers were also produced in response to a
subpoena from the SEC;
o Conducted interviews with select Company officers and accounting
personnel; and,
o Reviewed selected authoritative accounting literature and
pronouncements.
CONCLUSIONS
Based on the procedures performed through the date of this report, we have
reached the following conclusions. The balance of this report has been
organized in a manner to correspond with the areas of apparent accounting
irregularities noted during the conduct of our work. Please appreciate
that our work is ongoing, and, as such, additional information may be
forthcoming that could result in a modification of the following
conclusions.
Accounts Receivable
During our investigation and analysis, we identified several accounts
receivable balances which appear to be uncollectible and for which no
allowance had been provided. In some cases, the receivables were more
that a year old. Based on our analysis, the Company did not make adequate
provision for uncollectible receivables on a timely basis.
Inventories
We analyzed the methodology employed by the Company for valuing work in
process and finished goods manufactured by the Company. The Company's
methodology for valuing these inventories was to record the carrying value
of these inventories at a percentage of the list price of the completed
products. These inventories should be valued based upon the cost of raw
materials used in the manufacturing process and the labor and associated
overhead required to complete the manufacturing processes.
We reviewed the methodology used to determine the allowance for
obsolescence of raw materials and finished goods inventories. Based on
our analysis, it does not appear that an adequate level of reserves for
possible inventory obsolescence had been established by the Company. In
many cases, raw materials that had not been used in many years and
finished goods inventories that had not sold in many years were carried at
their full value, with no provision for obsolescence.
A significant portion of the recorded amount of inventory consisted of
manufactured products which were referred to by the Company as "reject
notifications". Our understanding of the nature of these items is that
they are manufactured finished products that had failed to meet the
customers standards and/or were not functioning as intended. These
products are retained by the Company, as possibly some components of the
products could be recovered and used, especially if those specific
component parts were no longer available. Generally, however, we
understand it is more costly to rework a defective item than to
manufacture a new one, since labor is a significant component of the
product cost. Returned inventory that is not expected to be sold to other
customers should not be recorded in inventory unless it has a salvage
value, in which case it should be recorded at that value.
Prepaid Expenses
As a result of our analysis of the components of prepaid expenses, we
determined that a significant portion of the account balance represented
amounts that were, in fact, period expenses which should not have been
recorded as an asset.
Machinery and Equipment
The machinery and equipment balance included in the financial statements
of the Company include the costs relating to finished unit prototypes.
These prototypes were pre-production finished products that were
manufactured by the engineering department, generally in advance of a firm
customer order. The prototypes are kept on hand by the Company, but
appear to have limited future utility. These costs should have been
charged to expense, in a manner similar to research and development costs,
and not deferred.
The Company's policy was to capitalize labor and related overhead incurred
to install machinery in its facilities. The amounts capitalized were not
supported by time records of the individuals involved in the installations
and the overhead burden rate applied to payroll costs was not supported by
any analysis of the underlying costs. The amounts capitalized were
significant in comparison to the cost of the equipment purchases. Labor
and overhead costs incurred to install equipment should not be capitalized
unless the amounts are based on time records, actual payroll costs, and
actual overhead costs.
The Company recorded depreciation based on lives that appear to be in
excess of the useful lives of the equipment and had calculated
depreciation assuming a residual value of 35% for most equipment, which
appears to be in excess of the residual value to be expected upon to
disposal of the equipment. Depreciation should be based on a realistic
estimate of the residual value of the equipment, if any, and on the
estimated useful life of the equipment, including consideration of
technological changes that could render the equipment obsolete.
The Company had capitalized as equipment, a number of amounts that
represent period costs. Period costs should be expensed as incurred.
Leasehold Improvement
The Company also capitalized significant amounts of labor and related
overhead as leasehold improvement. Such costs should not be capitalized
unless they relate to the actual construction of leasehold improvements
and are based on time records, actual payroll costs, and actual overhead
costs. Ongoing costs to maintain the existing facilities should be
expensed as incurred.
Long-term Inventory
The Company included amounts in its financial statements identified as
long-term inventory. In some cases the Company was required to maintain
an inventory of the product produced for a particular customer, e.g. the
U.S. military, beyond the term of the original contract. Generally,
however, the customer had no obligation to purchase the additional
inventory. An allowance for obsolescence should be provided for long-
term inventory that is not subject to a purchase contract, or is not
expected to be sold in reasonable period of time for an amount in excess
of its carrying value.
Patents
The Company capitalized labor and overhead costs incurred to develop new
products and apply for patents. Such costs should be expensed as incurred
as research and development costs. Third party costs related to patents
awarded to the Company should be capitalized and amortized over the life
of the patent, subject to impairment testing under SFAS 121.
ISO Registration Costs
The Company capitalized labor and overhead and third party costs in
connection with the Company's ISO registration. Such costs should be
expensed as incurred as they represent period costs.
Other Assets
The Company capitalized certain costs as other assets which are period
costs and should be expensed as incurred.
Deferred Income Taxes
A net deferred income tax liability was included on the balance sheets as
of December 31, 1998, December 31, 1999 and March 31, 2000. The tax
effect of the above adjustments will reduce the net deferred tax liability
to zero. A deferred tax asset should not be recorded, unless management
can establish that it is more likely than not that it will be realized.
Ship-in-Place Sales
Ship-in-place refers to the Company's practice of recording sales prior to
the completion and shipment of the products. Our review indicated that,
in most instances, such sales did not meet the requirements for revenue
recognition for bill and hold transactions. Sales should not be recorded
prior to the completion of the product and shipment (FOB Vari-L's
facilities) to the Company's customer.
During 1998, an entry was recorded that reversed receivables which had
previously been recorded for ship-in-place sales and an offsetting
adjustment was recorded to increase fixed assets. The Company appears to
have discontinued the practice of improperly recording sales and
receivables for "ship-in-place" sales at the time these adjustment to
receivables and fixed assets were made.
* * * * *
As discussed above, our conclusions and observations are based solely on
the work performed to date. Additionally, our analysis was conducted
using the financial records and analyses made available to us by the
Company, the sufficiency and completeness of which cannot be determined.
As our work is on-going, we reserve the right to amend or append, as
appropriate, the conclusions set forth above should additional information
be forthcoming. However, we do not recognize a continuing obligation to
update our work unless requested by the Company and agreed to by KPMG LLP.
Very truly yours,
KPMG LLP
/s/Richard W. Connor
Richard W. Connor
Manager Partner
RWC/ltw
